Stock Review: SIA Engineering

SIA Engineering (SIAEC) is a company providing aircraft maintenance services. I have been a shareholder of SIAEC for a few years but I had not really read their financial reports in detail. There are 3 reasons why I bought their shares, in order of priority:

1. High barrier to entry -> Economic Moat
2. Very low staff turnover -> Human Capital Moat
3. No debt, net cash -> Financial Moat

Unfortunately, its share price had been falling ($5.10 in Jul 2014) and falling ($3.80 in Sep 2016) and falling ($2.90 in Nov 2018) and falling ($2.20 in Dec 2018)... now $2.40. I wonder if there are problems with my 3 reasons.

Economic Moat

Every quarter, SIAEC had been reporting decreased in revenue, due to new planes that require fewer (fewer engines (from 4 reduced to 2) and higher mileage between servicing intervals) and shorter (improve designs and technology) servicing, which is a good thing if you think about air travel as a whole, because planes are safer and turnaround times are shorter. This means that airlines with newer planes will spend less on maintenance, which is bad for SIAEC. The good thing for SIAEC is that there are also more planes now because planes have become cheaper to acquire and maintain.

While aircraft checks have become fewer and shorter, I believe that the complexity has increased. This is because software is likely the enabler for these hardware improvements. This means that a maintenance engineer has to also learn how the software controls the hardware, in addition to all the new planes and the constant software updates these planes receive. As the servicing interval is further apart and maintenance window shorter, a maintenance engineer also needs to have a lot more experience to rectify problems and also identify potential issues in a shorter duration. SIAEC is in a very specialised area of business and this gives it its economic moat. It's very unlikely you will see another competitor beyond the existing one -- ST Engineering -- which mainly deals with military aircraft maintenance.

As long as aircrafts are in use, there will be a demand for aircraft maintenance services. This moat should still exist for a while..

Human Capital Moat

Being so specialised, SIAEC will likely have recruitment issues because staff can only come from a similar aircraft maintenance company based outside of Singapore, ST Engineering, military, or university/polytechnic graduates. Salaries also need to be higher. The good thing is they have very low staff turnover of 2%. If you are an aircraft engineer seeking a job switch, then you either join the defence/aviation government agencies, or pre/post/sales teams of Boeing/Airbus/Rolls Royce/similar in Singapore, or leave Singapore to join a similar company elsewhere. The community is small.

At 2%, I think it's a very good indicator that their engineers are well looked after. This is very important because the quality of services delivered depends on them. The only risk is potentially retirees leaving over the next few years, but this risk is present in every company in Singapore, because of the baby boomers generation. It just has a greater impact for companies dealing with very specialised products and services.

SIAEC Annual Report 2017 Page 29

Financial Moat

SIAEC has no debt throughout the years, which is good, but you may wonder if they are overly stingy with investments (~$30M in capex and intangible assets, 3Q18, pg7). Unfortunately, it's not stated what these investing activities are, but we can guess that it is around robotics, automation, and new toys they are trying out. Their Dividends from investments ($85.7M, 3Q18 pg7) = 2 x Net cash from operating activites ($39.8M, 3Q18 pg6). (I am dreaming of the day where my dividend from investments = 2 x my employment income too...). These numbers suggest really frugal and long-term financial management, which is something I really like about them.

Valuation

Net profit margin was 14.6% for 9 months ending 31 Dec 2018, compared to 16% a year ago. This was calculated with profit attributable to owners of parent / revenue. To me, it's a close enough figure to show that they are keeping a close watch on expenses too. Usually for companies that rely on human capital to deliver services, drops in revenue eat into profit margins, so it's important that the margin isn't too lean (i.e. <5%) and doesn't change too much (i.e. >5%).

At $2.40, it is just a little higher than its historical low of $2.20 on 26 Dec 2018. A dividend of $0.12 may not be too much to ask for, although the market is likely pricing in a lower dividend of $0.10 (because historically, SIAEC's yield hovers around 4%).

To determine what price to buy at, you ask yourself how badly you want to buy, and how much margin of safety you want to have. Assuming a lower dividends gives you a higher safety margin. If you want it badly, you just buy regardless of the price, like what I did. And if you like it so much, you buy more every time the price falls 10%.

$2.40, $0.12 dividend = 5%
$2.40, $0.10 dividend = 4.1%
$2.20, $0.12 dividend = 5.4%
$2.20, $0.10 dividend = 4.5%

I may be blinded by my vested interest in SIAEC, but I still like their moats.

Stock Review: Hyflux's Restructure Plan to erase $3.3B unsecured debt

If you need a summary of the Hyflux re-organisation process, you can read the FAQs at Hyflux website and Q&A from Second Townhall Meeting with Holders of Perpetual Capital Securities and Preference Shares .

Key points extracted, words in square brackets added by me:

[Internal Factors:]

1. While the Group reported losses in 2017 for the first time in its history, it had also regularly kept the market abreast of its plans to divest the Tuaspring project as well as its discussions with potential strategic investors.
2. [Unsuccessful Tuaspring sale]

[External Factors:]

1. Tuaspring was the largest asset Hyflux has invested in. In line with the business model, Hyflux sought to divest Tuaspring about a year after the power plant started operations in March 2016. Unfortunately, at that time, the poor market conditions hindered the divestment efforts.
2. The oversupply of gas in the Singapore market resulted in depressed electricity prices which adversely impacted Tuaspring’s financial performance when it started operating. The average wholesale electricity price in 2016 (when Tuaspring power plant started operations) was at $63/MWh, compared to $220/MWh in 2011 (when the project was first awarded to Hyflux). [Main reason, like how certain US oil companies went bankrupt when oil prices fell 80% because they priced projects based on best case scenarios and were over leveraged.]

[Unsuccessful Tuaspring sale]

1. The effort to divest Tuaspring started in January 2017.
2. DBS and CICC Bank were appointed as advisors for the divestment exercise.
3. By August 2017, more than 50 parties had indicated an interest in Tuaspring and had been provided access to the information memorandum concerning Tuaspring following written approval to disclosure being received from PUB. This information memorandum provided high level information on the asset.
4. As a result of this exercise, the company received several preliminary non-binding bids, all of which were subject to agreement on the investment structure, regulatory and other approvals, and completion of detailed due diligence. Three of these indicative bids attributed an enterprise value of S$1.4 bn to the Tuaspring project. [Entreprise value isn't asset value; it's the sum of how much it will cost to buy over the plant.] These came from a PRC SOE, a private UAE party and a subsidiary of a Singapore listed company.
5. However, these numbers were not final but subject to various conditions, investment structures and further due diligence.
6. To conduct further due diligence (which required obtaining access to more confidential information relating to Tuaspring) and to make a binding offer, an interested party needed to be approved by PUB to be granted access to such confidential information.
7. By May 2018, none of these parties had completed their due diligence processes, and the time required to complete such due diligence and receive an offer was likely to take a much longer period of time. With the weak electricity market not likely to recover in the near term, the Group will continue to suffer losses. As such, Hyflux decided to commence a transparent financial reorganisation supervised by the High Court of the Republic of Singapore.
8. The effort to divest Tuaspring continued in July 2018 through a collaborative sale process with the sole secured bank lender, Maybank.
9. Of the parties that had expressed an interest previously, only 8 requested to be pre-qualified by PUB.
10. Of the 8 parties, only 2 local parties [Keppel Corp and Semb Corp] were pre-qualified by PUB, of which 1 submitted a conditional bid [Semb Corp] in early October 2018.
11. This conditional bid would have been insufficient to repay Maybank. [Maybank's loan = $700M ]
12. Maybank agreed to extend the relevant deadlines for the collaborative sale process but to-date no further offer has been received from the other pre-qualified local party.
13. No further request for pre-qualification has been made by any other interested party nor have any other offers been received.
14. The Board is duty-bound to consider any offer that is made and compare that against the proposed investment by SMI.
15. At present, the best option in all the circumstances, is the proposed investment by SMI. Before the scheme meeting on the proposed investment at the end of March 2019, the Board will consider any better offer that is received. To-date no other offers have been made.
16. Please also refer to the SGX announcement issued by Hyflux on 28 January 2019 regarding the Tuaspring sale process and related news reports: http://investors.hyflux.com/newsroom/20190128_161822_600_P8YLNZWOKM8HC60B.1.pdf

How I read all these

How much unsecured debt is there? S$2.6B for Hyflux Ltd only or $3.3B including subsidiaries

Read the Scheme document for Hyflux Ltd Creditors. Summation is my own as the total isn't stated.

Items #1 to #5 appear in the financial statement Balance Sheet as Liabilities, $1.65B.

Items #6 to #7 appear in the financial statement Balance Sheet as Equities, aka off-balance-sheet-liabilities $1.8B.

1. $572.1M - Facilities
2. $136M - KfW
3. $265M - Notes Series 8,9,10
4. $668.1M - Contingent
5. $11.3M - Other Trade Creditors
6. $500M - Perpetual Capital Securities @6%
7. $400M - Preference Shares @8%
8. $72.3M - Subordinated Scheme

Page 193 states how $3.3B debt will be erased with SM Investments's $400M. Debt from the other 3 subsidiaries are stated too. That's 88% of debt magically disappearing from the books.

1. Olivia Lum Volunteers To Contribute Her Entire Stake Of 267 Million Hyflux Shares And Securities Solely To The Other Holders Of Perpetual Capital Securities And Preference Shares As Part Of Restructuring Plan --> She could have also done this by selling Tuaspring to Semb Corp at say $530M too.
2. Hyflux was following Singapore government’s instructions to prepare for 8 million population and industrial expansion. --> This means that Tuaspring isn't operating at full capacity, however, we have no visibility on the % utilisation, something like occupancy rate of a building you rent out.
3. Maybank holds the secured debt backed by tuaspring at a value of $700M. They have the best bargaining powers now. --> Maybank still has hope to get back $700M because they are not part of the restructure plan.
4. Tuaspring is operating at a $70M loss in 2016 (Hyflux response to SIAS letter Page 12, Q17) based on last audited accounts. In the restructure plan, nothing is mentioned about this, but we know that an indonesian tycoon will own 60% of it and ALL other Hyflux assets with $0 liabilities (because all will be written off)at a steal -- just $400M! Equivilantly valuing all assets at $400M / 60% = $667M.

1Q2018 Financial Reports

1. Based on 1Q2018 reported $24M loss, Earnings Per Share was -4.53 cents (-1.82 cents in 1Q2017), or -1.57 cents (1.6 cents in 1Q2017) excluding Tuaspring. Based on 785M shares, Tuaspring's 1Q2018 loss was -2.96 cents/share (-3.43 cents in 1Q2017) or $23M ($27M in 1Q2017).
2. $3.6B assets of which tuaspring is under asset-held-for-sale at $1.47B, $2.6B liabilities (of which $0.56B belongs to tuaspring).

Salim Smart

This is an awesome deal for SM Investments to own 60% of Tuaspring at a fraction of Semb Corp's offer. He deserves to be a tycoon. Assuming Semb Corp paid $530M, including $560M of liabilities, it would have paid $1.09B.

For Hyflux shareholders, the 785M units will be diluted 25 times. I hope I am interpreting this correctly from Page 193, that post re-org, ordinary shareholders own 4%. This also means that there will be approximately 785M x 25 = 19.625B units without shares consolidation.

In terms of paper value for 1 unit of Hyflux share post re-org, it's 3.4 cents ($667M / 19.685B units). Based on last traded price of 21 cents in May 2018, it's -84%.

For Perpetual Capital Securities or Preference Shares holders, not Hyflux shareholders, for every $1 owed to you, Hyflux will return you 10% in the form of 3 cents cash + 2.26 units of Hyflux shares (assuming 19.625B base, 19.625B x 10.38% / 900M = 2.26 units) supposedly worth 7.69 cents. If you have 10 units of shares (or $100/unit x 10 units = $1,000 worth), the restructure offer is to redeem your 10 units at $30 cash + 2260 units of Hyflux shares worth $76.90 instead of $1,000 cash.

Is there a better way out?

If I have the answer, I will probably be an investment banker, and not a nobody writing stock reviews? Here are my thoughts:

Firstly, Tuaspring's asset value should not have been stated as $1.47B. It should have been $1.47B - $0.56B = $0.91B. This can quite misleading in various contexts.

Secondly, the interest payments are suffocating. Although the interest rate for the bank debts were not stated, but we can assume it to be 5%, a bit lower than the 6% paid to retail investors, because usually banks aren't willing to lend, hence seek retail investors. 

If the $3.5B debt is re-negotiated

@5% = $175M/year

@2% = $70M/year

Personally, I think re-negotiating the debt @2% is one option, while they work on making Tuaspring profitable and then selling it off. Given the current stand-off situation, even if Hyflux offers @0%, I bet many creditors will choose 0% over the 10% redemption offer, similar to what Maybank is doing, hope for gas prices to go back up. 

Thirdly, if there is synergy between Tuaspring and Salim's businesses, then work on partnership deals to improve its profitability. I am not a Tuaspring expert, but minimally, I will think that scaling down operations is one way to cut cost. In addition, gas prices have fallen by two-thirds, so it won't be too unreasonable to re-negotiate the concessions with the government? I don't know.

The writer owns 130 units of Hyflux Preference Shares.